COVID-19 and Debt Crises in Developing Economies - IMF F&D
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- Authors: M AYHAN KOSE, FRANZISKA OHNSORGE, PETER NAGLE, NAOTAKA SUGAWARA
- Published: June 1, 2020
Overview
- The COVID-19 pandemic has hit emerging market and developing economies already experiencing the largest, fastest, and most broad-based increase in debt in the past 50 years.
- Since 2010, total debt in these economies rose by 60 percentage points of GDP to a historic peak of more than 170 percent of GDP in 2019.
- China accounted for the bulk of this increase, but the debt buildup was broad-based: in about 80 percent of these economies, total debt was higher in 2018 than in 2010.
- Excluding China, debt rose by 20 percentage points of GDP, to 108 percent, in 2019.
- As these economies respond to the pandemic, their debt will only increase.
Historical debt waves and common features
- Three prior broad-based waves of debt accumulation between 1970 and 2009:
- 1970–89: Sovereign borrowing in Latin America and low-income countries culminating in early 1980s crises and subsequent debt relief and restructuring.
- 1990–2001: Private-sector and sovereign borrowing in east Asia and the Pacific and Europe and central Asia; crises during 1997–2001 required large-scale bailouts.
- 2002–09: Private-sector borrowing in Europe and central Asia from EU-headquartered megabanks; the global financial crisis led to bank bailouts and pan-European resolution.
- Common elements across waves:
- Began during periods of low real interest rates and were often facilitated by financial innovations.
- Ended with widespread financial crises coinciding with global recessions or downturns (1982, 1991, 2009; downturns 1998, 2001).
- Crises triggered by shocks that sharply increased investor risk aversion, risk premiums, or borrowing costs, followed by capital flow sudden stops and deep recessions.
- Followed by reforms: greater reserve accumulation, inflation targeting, exchange rate flexibility, fiscal rules, and stronger financial sector supervision.
The fourth wave (since 2010) — characteristics and differences
- Key characteristics:
- Debt has reached record highs; private sector debt has risen particularly fast.
- Among commodity exporters, public sector debt increased substantially after the 2014–15 commodity price plunge.
- Average annual increase in debt since 2010 of almost 7 percentage points of GDP for this category of countries—significantly larger than during each of the previous three waves.
- Total debt rose in almost 80 percent of these economies and by at least 20 percentage points of GDP in more than 45 percent.
- Low-income countries’ debt rose to 65 percent of GDP in 2019, up from 47 percent of GDP in 2010.
- Changing debt composition and vulnerabilities:
- Debt has risen in the nonbank financial system, which appears more lightly supervised and less resilient than the restructured banking system.
- Share of government debt held by nonresident investors climbed to 43 percent in 2018.
- Foreign-currency-denominated corporate debt rose from 19 percent of GDP in 2010 to 26 percent of GDP in 2018.
- Among low-income countries, more than half of government debt is on nonconcessional terms.
- Outcome: Emerging market and developing economies entered the pandemic with mounting vulnerabilities, repeating a decade of growth disappointment.
Pandemic shock and near-term risks
- The pandemic abruptly ended financial market tranquility and is testing the resilience of economies, institutions, and policies.
- The current global recession is unusually severe and reaching into every corner of the global economy, increasing the likelihood that some economies will be tipped into widespread debt distress.
- Poorer prospects for a robust rebound, possible repeat outbreaks, and mounting backlash against globalization further weaken outlooks.
- Fiscal deficits in these economies are expected to widen by about 5 percentage points of GDP, on average, in 2020 (IMF 2020).
Policy priorities to weather the pandemic and restore sustainability
- Four broad strands of policy recommendations drawn from past debt waves:
- Sound debt management and transparency:
- Ensure today’s debt can be repaid tomorrow.
- Keep borrowing costs in check, restore debt sustainability, and contain fiscal risks.
- If central banks contribute to fiscal financing, establish frameworks ensuring a return to pre-pandemic monetary policy to bolster investor confidence.
- Creditors, including international financial institutions, can promote common standards.
- Good governance:
- Spend borrowed funds wisely to support health and productive investment.
- Strengthen bankruptcy frameworks to prevent debt overhangs from weighing on investment.
- Effective regulation and supervision:
- Temporary regulatory easing may be appropriate now, but proactive regulation and supervision are needed to identify and act on emerging risks.
- Deeper financial markets during recovery can mobilize domestic saving as a more stable financing source than foreign borrowing.
- Robust macroeconomic policies:
- Maintain sound monetary, exchange rate, and fiscal policy frameworks to safeguard resilience.
- Flexible exchange rates can soften short-term shocks and discourage balance sheet mismatches over the longer term.
- Adjust revenue and expenditure policies to expand fiscal resources for health and support for vulnerable groups.
- Invoking escape clauses to fiscal rules during the crisis may be necessary, but fiscal rules should guide the eventual unwinding of stimulus and return to fiscal sustainability once recovery takes hold.
Conclusion
- The pandemic’s shock will stretch even the most resilient economies; global cooperation and support are critical.
- The central lesson from previous debt waves is that domestic policy choices and frameworks are essential to fending off financial crises and restoring sustainability.
COVID-19 and Debt Crises in Developing Economies - IMF F&D
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